How can equity management strategies be tailored to different types of investors?

In 2024, the global venture capital investments rose by 5.4% to $368.3 billion, highlighting the growing role of startup investors in fueling innovation. With the growing passion for startup investments, streamlining equity management has become even more crucial. This is a practice that plays a key role in managing dilution, optimizing returns and executing fruitful exits.

However, not all investors approach equity management the same way. After all, angel investors, venture capital (VC) firms and private equity (PE) firms have distinct objectives, risk profiles, and strategies when managing equity in startups.

While you may not find an equity management strategy that perfectly meets your needs, you can always develop customized strategies for your specific goals. This requires an in-depth understanding of your own risk exposure, management burden, objectives, and investment tenure.

What are the equity management needs of startup investors?

Let us start our discussion by understanding the unique characteristics of three common types of startup investors and their different equity management needs. This will give you insights into how equity management strategies can be tailored to meet the unique needs of different types of investors.

Angel investors

Angel investors are individual, accredited investors who enter at the pre-seed or seed stage and often take up mentorship roles. They enter at the riskiest stage in a startup’s journey, often when its valuation cannot be determined.

An angel investor will want to exit at the earliest liquidity event which is typically a follow-on funding round unless the startup gets acquired. Such investors will aim to have a portfolio of 10-20 startups.

Given their active management style and risk exposure, such investors will want to regularly monitor the equity structure to track dilution risks.

Venture capital firms

Venture capital firms enter at the early stage or growth stage. Typically, a venture capital firm’s general partners will launch and manage a fund where accredited investors and institutional investors can join as limited partners. A single venture capital firm can have multiple funds, and each fund could have dozens of startups.

Venture capital firms typically have exposure to a much larger number of startups compared to angel investors and are accountable to a range of investors. As a result, they require a streamlined equity management platform that can generate detailed reports on dilution, valuation history, and board resolutions upon request by their limited partners.

While VC firms do not engage directly in the day-to-day management of portfolio startups, they often influence strategic decisions through board seats and may require detailed, periodic reporting to monitor performance and guide their involvement.

Private equity firms

Private equity firms have a similar structure to venture capital firms but they enter at a later stage and their influence is quite different. A venture capital firm is likely to support initiatives that drive growth. Such initiatives include development of new and experimental products and aggressive geographical expansion.

In contrast, a private equity firm would want to enhance the valuation by achieving better operational efficiency. To do so, they would push founders to optimize supply chains and production processes, and strategically expand into new markets.

In some cases, private equity firms acquire controlling stakes in their portfolio companies. Hence, private equity firms may take a more active role in management.

As a result, private equity firms may require an equity management solution that tracks dilution, helps manage stock-based compensation plans, and can incorporate performance reporting for real-time valuation updates. This would help them manage their returns, incentivize key performers, and accurately predict peak valuations to maximize exit opportunities.

Common equity management strategies

There are many equity management strategies, but only a select few are suitable for startup investors. Below, we highlight the most relevant options.

Diversification

You can diversify your portfolio by investing in different assets instead of investing in only one asset. This will limit the damage your portfolio takes from a particular investment’s failure. To diversify effectively, you should aim to invest in startups of different sizes, industries, and regions.

Due to high ticket sizes in startup investments, the level of diversification you can achieve depends on your dry powder.

Sector rotation

As consumer preferences, macroeconomic conditions, and business needs evolve, the most disruptive sectors shift accordingly. Currently, AI startups are drawing the most investor attention. However, as AI’s data demands and energy needs grow, data storage or clean energy startups may become more valuable in the future.

Hence, focusing solely on AI startups may not be the best long-term strategy. To capitalize on emerging trends and maximize returns, investors should shift their focus from one sector to another.

Follow-on investing

Whether an investor can make a follow-on investment depends on their liquidity needs. Typically, such investments are made when the portfolio startups show greater promise than other alternatives and the chances of future liquidity events are high.

Use of convertible securities

Simple Agreements for Future Equity (SAFE) notes, a type of convertible security, are designed to sidestep the difficulties in determining an early-stage startup’s valuation. Other convertible securities such as convertible bonds and preferred shares are used to meet investor needs.

Revenue-based financing

Some startups may reach a point where they have steady, growing revenue, but market conditions suggest that the next funding round could be far off. In these situations, investors might offer revenue-based financing to address exit uncertainty and secure a partial return on their investment.

Staggered exit planning

Investors may request the inclusion of buyback clauses that are triggered upon the achievement of specific milestones. Another way to ensure gradual exits would be provisions that require incoming investors to purchase a certain percentage of existing investors’ stakes. In some cases, a buyback clause might be triggered after a specified number of years if liquidity events do not occur.

How to craft the ideal equity management strategy for each type of startup investor?

We have built an understanding of equity management strategies and investor needs, let us explore how to tailor these strategies as per investor needs.

Equity management strategy	Angel investors	Venture capital firms	Private equity firms
Diversification	Since stage-wise diversification within startups is not possible for angel investors, they must consider sector-wise diversification even if it does not provide mentorship opportunities.	VC firms can launch funds that target different stages or sectors instead of diversifying within a single fund, as each limited partner’s investment needs will be different, which makes reporting and exit facilitation complicated.	PE firms should also explore sector-wise diversification and attempt to shortlist opportunities based on scope for value creation through optimization of organizational processes.
Sector rotation	Angel investors may consider sector rotation when an emerging sector aligns with their expertise or network.	VCs may launch new funds into emerging sectors that show long-term growth potential.	PE firms may rotate capital into industries that have reached stability and show the possibility of achieving high margins through improvements of management practices.
Follow-on investing	To meet the diversification goals and the liquidity needs, follow-on investing should be avoided by angel investors.	VCs should maintain a reserve to be used for follow-on investments to maintain equity stakes and support successful startups in later rounds.	PE firms may use follow-on investments to retain controlling stakes in promising ventures.
Use of convertible securities	Angels use SAFE notes to defer valuations.	Depending on the market conditions, investor needs, and company situation, VCs may opt for warrants or convertible bonds. VCs also use SAFE notes to defer valuations.	PE firms use convertible securities sparingly and prefer common stock to maintain control and voting rights over portfolio companies.
Revenue-based financing	Angels cannot pursue this strategy as most pre-seed and seed stage startups do not have a steady flow of revenue.	VCs may extend revenue-based financing to help scale revenue-generating startups.	PE firms may combine revenue-based financing with traditional equity financing if promoters have concerns regarding equity dilution.
Staggered exit planning	Angels are less likely to opt for staggered exits since they usually plan on complete exits through the next funding round or acquisition.	VC funds may propose structured exit plans with buyback clauses to accommodate limited partner needs in fundraising droughts.	PE firms create detailed, staggered exit plans, often targeting specific milestones in portfolio company development.

Eqvista – Track, manage and optimize equity!

Equity management begins with deciphering market trends and understanding investment needs to form sound strategies. However, the most important part in establishing processes that reduce operational burden and implementing robust monitoring systems. This approach ensures you meet your investment goals, avoid human errors, and remain agile enough to make timely strategic adjustments.

At Eqvista, we have developed an all-in-one equity management platform. From issuing stocks and managing shareholders to handling QSBS attestations and 409A valuations, we can guide you through the complexities of equity management while ensuring tax compliance at every step. Contact us to learn how we can simplify equity for you!